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Import competition, investment

finance, and cumulative
decline in the US steel industry,
19621981
Robert A. Blecker

American University , Washington

Published online: 02 Nov 2006.

To cite this article: Robert A. Blecker (1991) Import competition, investment finance,
and cumulative decline in the US steel industry, 19621981, International Review of
Applied Economics, 5:2, 171-195, DOI: 10.1080/758533096
To link to this article: http://dx.doi.org/10.1080/758533096

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Import competition, investment

finance, and cumulative decline in the
US steel industry, 1962- 1981

Downloaded by [University of Auckland Library] at 20:20 14 February 2015

Robert A. Blecker* American University, Washington

This paper analyses the effects of import competition on the financing of investment in the US steel industry. Model simulations show that import penetration
reduced average annual investment spending by about one-quarter over the
period 1962-81, mostly as the result of a squeeze on profit margins which constrained internal finance. Assuming that this reduction is investment caused productivity growth to slow down, the benefits of allowing imports for steel
consumers are estimated to have been relatively small in the long run. The
analysis supports the concept of cumulative causation in competitiveness due
to constraints on investment financing.

I Introduction
You can't stand still in this new industrial era. If you don't expand and move
ahead you are going backward. The longer you take to make up your mind what
you are going to do the further ahead your competitor has gone - and the harder
it will be for you to make up lost time; if you can. (Editorial. The Iron Age:
5 January 1956)

This quote from the leading U S steel industry trade journal was written prophetically at a time when industry executives insisted that (apart from their
labour unions) they had no fundamental problems to worry about (see
Means, 1962; Broude, 1963). Only a few years later, the industry began to
face an onslaught of imports which revealed a genuine loss of competitiveness, as documented by the U S Federal Trade Commission (FTC, 1977),
Anderson and Kreinin (1981), Crandall (l981), and Barnett and Schorsch
(1983). The editorial suggests that a small initial competitive disadvantage

The author would like to thank Donald Harris, Bert Hickman, Nathan Rosenberg, and Gavin
Wright for help at various stages in this project, and David Houston, Fred Lee, and two
anonymous referees for helpful comments on earlier drafts. Robert Crandall, Mary Deily.
and Jerome Mark provided some of the data series. The American University and the
Economic Policy Institute provided financial support. The author alone is responsible for the
views expressed here and any remaining errors.
,

Edward Arnold !!ib9l

I !

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172 Import competition, investment finance, and cumulative decline

could permanently set back the development of the affected firms. Although
orthodox neoclassical economists have traditionally dismissed such ideas, at
least until recently (see, for example, Krugman, 1981), such a notion of
failure breeding further decline appears as simple common sense to the
business press.
Outside of neoclassical orthodoxy, the principle of cumulative causation
has long been accepted by neo-Keynesian economists, especially Kaldor
(1970; 1972). In Kaldor's conception, cumulative causation results fundamentally from increasing returns to scale, broadly defined to include learning effects, induced innovation, and increasing specialization as well as
static scale economies. According to Kaldor's 'laws,' productivity growth in
manufacturing depends on the rate of investment in capital equipment
embodying new technology; the rate of investment in turn depends primarily
on the growth of demand: 'Accumulation is financed out of business profits;
the growth of demand in turn is largely responsible for providing both the
inducements to invest capital in industry and also the means of financing
it.' (Targetti and Thirlwall, 1989: 314).
This Kaldorian perspective is incomplete, however, as it omits the equally
crucial role of the profit markup or price-cost margin. As Kalecki (1971),
Steindl (1952), and Eichner (1976) emphasized, the firm generates the gross
profits or cash flow required to finance its accumulation internally (as well
as to attract external funds) largely through its ability to maintain an adequate price-cost margin. The ability to maintain this margin is constrained,
in turn, by a number of factors, including international competition. Recent
studies by Dornbusch (1987), Feinberg (1986; 1989), Karier (1988), Mann
(1986), and Hooper and Mann (1989) have shown that import penetration
and currency appreciation can induce oligopolistic firms to cut profit
margins, both in theory and in practice. And the work of Fazzari and Mott
(1986-87), Fazzari and Athey (1987), and Fazzari e t a / . (1988) has confirmed
that financing constraints (internal cash flows) are important for limiting
investment spending.
These considerations imply a mechanism of cumulative causation for
industrial competitiveness. Industrial firms must invest in new plant and
equipment, embodying new vintages of technology, as well as engage in
research and development, sales promotion, and other activities required
to remain competitive and to expand their markets. This implies that the
development of an industry depends on, among other things, the ability of
the firms that comprise it to raise the capital funds required to finance their
investment programmes and other competitiveness-enhancing activities.
Therefore, one of the main ways in which success breeds further success is
the ability of successful firms to make above-normal profits which can be
ploughed back into further investment and innovation. In addition, firms
must be able to expand their markets fast enough t o justify continued high
rates of accumulation. Correspondingly, depressed profits and demand

Robert A. Blecker 173

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can prevent firms from making the expenditures required to restore their
competitiveness.
These factors suggest the possibility of 'hysteresis' in international competitive advantages or disadvantages.' In an open economy, the competitive position of national firms vis-a-vis their foreign rivals affects their
price-cost margins as well as the demand for their products. The markup
rate and output level together determine the internal flow of funds (given
fixed costs). The flow of internal funds, together with the growth of demand
for national products, affects the amount of investment and other expenditures which firms are able and willing to make in order to improve the
efficiency and quality of their production.' If most of the firms in an
industry cannot maintain the level of expenditures required to bolster their
competitiveness, then they may fall into a vicious circle of cumulative
decline.
In principle, the mechanism described here really applies to individual
firms rather than national industries; different firms located (or based) in
the same nation may be affected unevenly by the same competitive forces
depending on their respective cost structures, market shares, financial positions, etc. Nevertheless, the concept of the national industry is a useful level
of aggregation for US steel producers for several reasons. First, global steel
production has generally been dominated by national rather than multinational firms, and there was no tendency of US steel firms to invest overseas.
Secondly, until the 1980s. US steel production was highly concentrated
among a group of large oligopolistic firms with generally similar structural
characteristics. The largest of these, the United States Steel Corporation,
was a declining dominant firm with no significant cost advantage in its
steelmaking operations (Scherer, 1980: 239-40). Although US steel was
larger than its rival firms, its plants were similar in size and technology. Only
with the emergence of minimills in the late 1970s and early 1980s did the
industry structure become more heterogeneous. Thirdly, firm-level data are
not available for many of the variables needed for this study.
In a previous paper (Blecker, 1989), I confirmed that price-cost margins
for American steel products became sensitive to imports (as well as to
demand conditions) after a structural break in 1962, when imports permanently surpassed 5% of the domestic market. In this paper, I estimate
how this squeeze on profit margins, along with reduced demand, affected
the financing of capital accumulation in the US steel industry in the 1960s
and 1970s. In order to study this effect of import penetration, I adopt the
methodology of the 'cliometric' economic historian by simulating a model

A similar argument, posed at the macro level (for the manufacturing sector as a whole), is
found in Singh (1977).
2 Note that this implies the possibility of a trade-off, if a nation's firms can gain greater world
market share by reducing their profit margins.
1

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174 Import competition, investment finance, and cumulative decline

of industry behaviour under counterfactual assumptions about the degree
of import penetration. The main results which are obtained from this exercise are estimates of the cumulative loss of investment due to the increase
in imports from 1962 to 1981. Specifically, it is found that import penetration curtailed investment in the steel industry by about one-quarter compared with the baseline 'forecast' of the model.
In the model presented in this paper, I d o not endogenize the feedback
erfects that additional investment would have had in raising the industry's
productivity. Nor d o I attempt to estimate how wages (and other input
prices) would have behaved differently in the counterfactual scenarios. Unit
labour (as well as materials) costs are taken as exogenously given in the
estimation of the model. However, some crude estimates of the impact of
endogenous technical progress are made by running simulations in which a
higher rate of investment is accompanied by more rapid growth of labour
productivity, and comparing these simulations with 'static' ones assuming
exogenously fixed productivity growth. The reasons for this procedure are
discussed below.
In focusing on the role of imports in the decline of the US steel industry,
I d o not mean to deny that a considerable part of the industry's problems
in the 1960s and 1970s must be attributed to domestic structural changes
which slowed the growth of steel demand, as argued by Barnett and Schorsch
(1983), Lawrence (1983), and Grossman (1986), among others. Nevertheless,
in view of the continued debate over trade policy for steel, it is still worth
investigating the mechanisms by which import competition can affect the
development of the industry - and the consequences of doing nothing in
response. What kind of government intervention, if any, was or is warranted
for the US steel industry is a separate question which is beyond the scope
of this paper.
The rest of the paper is organized as follows. Section I1 describes the
model of the industry and discusses the theoretical rationale for the individual equations. Section 111 discusses the results of the model simulations
for the effects of imports on investment financing, assuming fixed labour
productivity. Section IV then compares the results of a simulation in which
labour productivity is assumed to increase more rapidly when investment is
higher. Section V concludes by considering some of the implications of the
analysis for both theory and policy. Diagnostic statistic on the fit of the
model are presented in an Appendix.
I1 Estimated equations of the model

The model described in this section draws upon and extends the previous econometric work of Mancke (1968), Rippe (1970), Jondrow (1978).
Crandall(1981), and Blecker (1989). The core of the model is the price equation, which captures the effect of import competition on the price-cost

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Robert A . Blecker

175

margin. In addition, equations for total demand and import demand show
how the growth of the internal market and the import share are determined
by relative prices and other variables. Demand conditions are then translated
into domestic output levels and utilization rates. The price-cost margin and
the level of output explain the flow of internal funds, given tax rates and
overhead costs. The flow of internal funds and the utilization rate in turn
are the main variables used to explain investment expenditures, as accelerator effects turn out t o be insignificant. The model also keeps track of
several important feedbacks, including the dividend payout rate and the
growth of capacity, while using dummy variables to control for certain unique historical episodes (the Korean War, the 1959 strike).
Estimated equations and identities for the complete model are given in
Table 1. The model is estimated using annual industry-level time series for
reasons of data availability. The sample period starts in the first year for
which the necessary lags of all the variables are available, which is 1949 for
most of the equations (see the notes to Table 1 for exceptions). The sample
period ends in 1981, just before the recession of 1982 which dramatically
transformed the industry's structure. In the crisis of 1982-83, the large,
integrated producers accelerated their abandonment of capacity and diversification out of steel, while the small, competitive mini-mills took over a
rapidly rising share of the shrinking domestic steel market (Barnett and
Crandall, 1986). The proportion of nonsteel investment spending by steel
firms rose sharply in the early 1980s as they moved to diversify more rapidly.
Nonsteel capital expenditures averaged about one-third of the total in
1979-81, and then jumped to about one-half in 1982-84, according to
American Iron and Steel Institute (AISI) data.'
The equations were estimated by 2SLS. except as noted in the table.
All variables for which no equation is given in Table 1 were treated as
exogenous; lagged endogenous variables were treated as predetermined
(except in equation 1.8). Limited information estimation procedures were
preferred due to the small sample size (33 observations), and so that any
possible errors in the specification of one equation would not bias the estimation of the other equations. Since the main objective is prediction, rather
than hypothesis testing, a few variables which improved the fit of the
baseline forecast are retained in spite of t-statistics which are low by traditional standards.
In discussing the individual equations, it is useful to start with the investment function which is so crucial to the results. As discussed above, the neoKeynesian tradition contains two approaches to investment: one which
emphasizes the growth of demand (the accelerator) and one which
emphasizes profitability (price-cost margins). In the case of the US steel

Separate steel and nonsteel investment series are not available before 1979.

176 Import competition, investment finance, and cumulative decline

Table 1 Estimated equations of the model
(l.l)a
INVEST, =

- 1.25
(-2.09)

,367 INTFUND,_, + ,361 INTFUND,_;,

(3.17)
(3.641

+ 0.7 1 CAPUTIL, , +
(1.42)

Rho =

1.17 CAPUTIL,
(2.731

0.73 DSTRIKE, _
(4.13)

1.5831.

0.73 DKOREA,
13.74)

,635
(4.18)

(Adjusted R2 = ,778; Durbin-Watson

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1 1 . 2 )log
~ INTFUND, = 6.71 + 1.17 log MARGIN,
(2.651 (2.51)

0.55 log OUTPUT,

(1.681

- 0.64 log TAXRATE, - 1 14 log OVERHEAD, , Rho = ,488

( - 1 581
1 - 2.47)
(2.69)
Adjusted R~ = 573; Durb~n-Watson= 1.841
(

1.3) MARGIN, = ( PRICE, - UNICOS TI II PIN VESTI

(1.4IC
log PRICE,

(Identity)

- ,166 + .51 1 log UNITCOST, + 402 log UNITCOST,_,

1-0.87) (5.81)
(4.11)

+ ,161 log DIVPNT, + . I 8 4 log OVERHEAD,

( 4 06)
(3.21)

+ ,394 (01962, x
(3.29)

10s CAPUTIL,) -

,058 (01962, x log IMPSHARE,)

(-0.71)

(Adjusted R2 = .995; Durbln-Watson = 1.834).

I1 .5)dlog DIVPNT, =

,943 + .61 1 log DIVPNT,_, + 168 log INTFUND,-,

1.71) 16.21)
( 2 18)

(-

+ ,091 log UNITCOST,

11.88)
Adjusted RZ = ,766; Durbin's h = 0.581 1.
(1.6) CAPUTIL, = OUTPUT,ICAPACITY,.

(Identity)

( 1.7Ie OUTPUT, = 1.38 + 1.12 (DOMCONS, - IMPORTS,)

(0.38) (24 8)
Adjusted R~ = .951; Durbin-Watson = 1.375)
(1.8)' CAPACITY, = 8.61 + ,893 CAPACITY,-,
(4.27) (42 1)

Rho =

1.52 INVEST,-, + 019 OUTPUT,_,,

(4.34)
(1.381

,434
(2 371

(Adjusted R2 = ,996; Durbin's h = 0.989).

(1 9) IMPSHARE, = IMPORTS,IDOMCONS,
(1.1019 log IMPORTS,

- 16.4

(-4.69)

453 log IMPORTS,_

16 26)

- 1.33 log IMPP91CE,+

(-

4.671

(Identity1

, + 1.42 log PRICE,

(4.53)

1.81 log DOMCONS, + ,735 DSTRIKE,

(5.25)
(3.16)

(Adjusted R2 = ,966; Durbin h = 1 238).

(1.1 1)9 log DOMCONS, = 14 4 - 502 log PRICE, + ,453 log PPINFMET,
(23.1)
(-4.00)
(2.97)

+ ,777 log YMFR, - ,00025

17.62)
( - 1.081

r2

(Adjusted R 2 = .891; Durb~n-Watson= 2.1 18)

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Robert A. Blecker

177

Notes: All stochastic equations were estimated over 1949-1981 by 2SLS unless otherwise
noted.
Numbers in parentheses are t-statistics.
'Log' means the natural logarithm.
See text for definitions of variables.
a Estimated over 1951 -81 by Fair's ( 1970) method. INVEST and INTFUND are measured
in billions of 1972 dollars. The sum of the coefficients on INTFUND is ,729. with a
r-statistic of 5.23. The sum of the coefficients on CAPUTIL is 1.89, with a r-statistic of
2.73.
Estimated over 1950-81 by Fair's (1970) method. INTFUND is measured in millions of
1972 dollars; OUTPUT is based on 1977 = 1.O.
The sum of the coefficients on current and lagged UNITCOST is ,913, with a t-statistic of
39.5 for the null hypothesis that the sum equals zero. The null hypothesis that the sum equals
unity can be rejected at the 5 % level (r-statistic of 3.75).
Estimated by OLS. INTFUND is measured in millions of 1972 dollars.
OUTPUT is based on 1977 = 100; OOMCONS and IMPORTS are measured in billions of
net tons.
I Estimated over 1951-81 by limited information two-step procedure la) in Hatanaka (19761.
CAPACITY and OUTPUT are based on 1977 output = 100; INVEST is measured in billions
of 1972 dollars.
IMPORTS and DOMCONS are measured in thousand net tons.

industry, accelerator effects turn out to have been statistically insignificant,

although demand played a role through the effects of capacity utilization
rates. On the other hand, profitability (as measured by lagged flows of internal funds) was highly significant in explaining steel investment. These conclusions may be drawn from the following regression e q ~ a t i o n : ~
INVEST, = - 1.95 - .004 ASHIP, - .010 ASHIP,-, - .001 ASHIP,-,
( - 1.38)(-0.34)
(-0.74)
(-0.16)
- .002 ASHIP,-3 + .349 INTFUND,- + .229 INTFUND,-2
(-0.28)
(2.19)
(1.39)
1.58 CAPUTIL, 1.49 CAPUTIL,-,
0.68 DKOREA,
(1.04)
(1.06)
(3.25)
+ 0.84 DSTRIKE,-,, Rho = .727 ( 1 )
(4.23)
(4.54)
(Adjusted R2 = ,748; Durbin-Watson = 1.568).

In equation (I), the dependent variable INVEST is new plant and equipment expenditures in blast furnaces and' steel works measured in constant
1972 dollars (US Department of Commerce, 1985). The accelerator effect
is represented by the distributed lag of ASHIP, which is the annual increase
in net product shipments (from AISI). Profitability is represented by INTFUND, which is internal funds (corporate net income plus depreciation plus
the change in reserves minus dividends), calculated from AISl financial

The sample period is 1951-81. The equation was estimated by instrumental variables using
Fair's (1970) method. Numbers i n parentheses are ;-statistics.

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178 Import competition, investment finance, and cumulative decline

data, and expressed in constant 1972 dollar^.^ CAPUTIL is the Federal
Reserve Board (FRB) index of capacity utilization in iron and steel.
DKOREA is a dummy variable set equal to 1 in 1952 to control for the
Korean War investment boom. DSTRIKE is a dummy variable for the 1959
strike, which is included with a one-year lag to capture the postponement
of investment expenditures until after the strike ended.
Since all the coefficients on the various lags of ASHIP are negative and
insignifi~ant,~
equation (1) was rerun with these variables omitted. The
resulting specification is shown as equation (1.1) in Table 1. Note that,
when the accelerator terms are omitted, the coefficients on internal funds
(INTFUND) are higher and more significant, while those on the utilization
rate are lower but also more significant.
Internal funds are determined by the simple accounting identity:
7F

= [(P-c)xF ] ( I -T ) ,

(2)

where ?r is internal funds, P is the price, C is average variable cost (unit

labour plus unit materials costs), X is output, F is fixed costs, and 7 is the
corporate tax rate. Since replacement investment generally raises productivity and thereby increases capacity, we are concerned with gross investment. Therefore, depreciation allowances are treated as part of the cash flow
or internal funds available to finance gross investment, rather than as part
of fixed costs.
The 'real' amount of gross profit in terms of output is:

where (P - C)/Pis the price-cost margin (PCM). Alternatively, real internal

funds can be measured in terms of their command over capital goods:

where Pi is a price index for investment expenditures. Rearranging (2b) and

taking natural logarithms yields:

log

( ? r / ~ ; )=

log [(P- c)/P;]+ log ( 1 - 7 )

+ log X + log (1 - f )
(3)

The AlSl financial data were deflated using the implicit price deflator for new plant and equipment expenditures in blast furnaces and steel works (PINVEST) based on 1972 = 100. The
financial data were corrected for the varying percentage of firms reporting each year by
dividing by the reporting firms' share of product shipments.
The sum of the coefficients on ASHIP is -.018 with a !-statistic of -0.49, which is also
insignificant. The insignificance of the accelerator terms in equation (1) probably reflects the
flat trend of shipments in the US steel industry, which grew at an average annual rate of under
I % during the sample period. The mean annual change in shipments is not significantly different from zero at the 5% level. Assuming that steel firms did not expect any long-term
growth of demand, they would view increases in demand merely as cyclical fluctuations.
~ ~ p a r e nsteel
t l ~firms didrespond to cyclical effects, judging from the positive coefficients
on the utilization rate.

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Robert A . Blecker

179

where f = F / ( P - O X . Although equation (3) is an accounting identity,

consistent measures of all the variables in equation (3) are not available. I
therefore treat equation (3) as stochastic equation (1.2) in Table 1. MARGIN
is the constant-dollar profit margin, defined by identity (1.3) in the table.
OUTPUT is the FRB index for the iron and steel industry (1977 = 100).
TAXRATE is the average effective tax rate for all manufacturing corpor a t i o n ~ OVERHEAD,
.~
which is used as a proxy for f, is the ratio of the
Bureau of Labor Statistics (BLS) index of nonproduction worker hours to
the index for production worker hours in steel (1977 = 100).
Identity (1.3) defines the gross profit margin in constant 1972 dollars.
PRICE is the average realized price of all steel products, in current dollars
per net ton, calculated from Census Bureau and AISI data.' UNITCOST
is the average direct cost of production workers' labour plus seven raw
materials (iron ore, coking coal, noncoking coal, steel scrap, fuel oil, purchased electricity, and natural gas) in current price^.^
Equation (1.4) then explains the price level, allowing changes in unit costs
to be passed on over two years. PRICE also depends on the dividend payout
rate, overhead costs, and - after a structural break when imports became
firmly established in the early 1960s (Dl962 is a dummy variable equal to
one in 1962-81 and zero earlier) - import penetration and capacity utilization. Previous studies (Mancke, 1968; Crandall, 1981; Blecker, 1989) have
confirmed the hypothesis of such a structural break, which is simply
assumed here. DIVPNT is cash dividends paid, in current dollars per net
ton of trend product shipments, calculated from AISI series.'' Dividends
are included as a proxy for the managers.' sense of their firms.' market
power (see Adelman, 1961; Means, 1962). IMPSHARE is the share of
imports in apparent supply (AISI). The price equation is not linearly
homogeneous with respect to direct costs, as the sum of the coefficients on
UNITCOST is significantly below unity (see Table I, note c). Apparently,
the combined pressures of trade union strength at home and intensifying

la

TAXRATE is the ratio of taxes paid after credits to income subject to tax, for total manufacturing, from US Internal Revenue Service, Storisrics of income, corporurion tux returns.
This is used as an instrument for the actual effective tax rate for the steel industry, which
would not be independent of the industry's realized profitability.
The method of calculating the average realized price was adapted from Crandall (1981),
as explained in Blecker (1989). Details on the derivation of all the data series used in this
paper are available from the author o n request.
The calculation of materials costs was based on the sources and procedures used in US FTC
(1977). with some modifications. The main source for physical input data was AISI. The
BLS index of production worker hours (1977 = 100) was used for the labour input, scaled
by the AlSl figure for wage employee hours (divided by the percentage of firms reporting)
for 1977. The wage rate is the AlSl measure of total employment cost per hour for wage
employees. Raw materials and energy prices were calculated from a variety of public and
private sources. Details are available from the author on request.
The log-linear time trend of net product shipments over 1945-83 is used for the denominator
o f DlVPNTto eliminate the effects of cyclical fluctuations in demand, which would be correlated with CAPUTIL.

Downloaded by [University of Auckland Library] at 20:20 14 February 2015

180 Import competition, investment finance, and cumulative decline

competition from abroad prevented US steel firms from fully passing on
their increases in direct costs.
The specification of dividends in (1.5) is adapted from Lintner (1956). The
current payout decision is based on the past level of dividends, with
adjustments made according to recent profitability. I use one-year lagged
INTFUND to represent profitability, since using current INTFUND would
result in circular reasoning in the context of the present model." Since
DIVPNTis measured in nominal dollars, I also add UNITCOST to control
for inflation, assuming that firms try to make nominal dividend payments
keep pace with wages and other costs (Eichner, 1976).
Equation (1.6) is an identity for capacity utilization. CAPACITY is the
FRB index based on 1977 output = 100. Equation (1.7) is used to link the
FRB output index to the physical data for steel product demand: domestic
consumption (DOMCONS), measured by 'apparent supply' (net shipments
plus imports minus exports), and IMPORTS. Equation (1.8) for steel
capacity is based on the presumption that past capacity is added to by oneyear lagged real investment (INVES7). Lagged OUTPUT is also included
as a proxy for expected changes in demand, which affect the rate at which
old capacity is retired. Including this variable improved the baseline forecast
of the equation, in spite of the low /-statistic.
Equations (1.9) to (1.11) determine the import share, import demand,
and total demand, respectively. Following a suggestion of Rippe (1970: 42),
I include lagged imports in the import demand equation (1.10) to represent
'the learning process involved in the purchase of imports'. IMPRICE is
the weighted average price of imports of five major carbon steel products
(bars, cold- and hot-rolled sheet, plate, and structurals), including estimated freight, insurance, and customs charges." The relatively high priceelasticity of demand for steel imports (about 1.4 in the short run and 2.6
in the long run) indicates that foreign steel products were good substitutes
for domestic products. Domestic consumption (DOMCONS) is the total
demand for steel products, measured by 'apparent supply' (domestic shipments plus net imports). The DSTRIKE dummy is used to control for the
surge of imports during the 1959 strike.
The BLS producer price index for nonferrous metals (PPINFME7) is used
in (I. 11) to represent the price o f substitute materials." YMFR is the FRB
index of manufacturing output, used as a proxy for the 'income' of steel consumers. Note that overall steel demand is relatively income-inelastic,

12

13

INTFUND is a function of MARGIN by (1.2). Since MARGIN = (PRICE-(/TOTCOST)/

PINVESTby (1.3), and PRICE is a function of D l VPNT by (1.4). if DIVPNTwere a function of current INTFUND, then current DIVPNT would be a function of itself.
This measure was adapted and extended from data in Crandall (1981). as explained in
Blecker (1989). The weights are the shares of each product type in net shipments.
The PPIs for concrete products and plastic materials result in similar estimated coefficients,
but PPINFMET yields the best fit.

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Robert A . Blecker

181

which reflects the structural decline in steel usage in an advanced economy.

The negative time-squared trend also indicates accelerating technical progress in finding substitutes for steel.I4 And the sensitivity of total steel
demand to relative prices may also be conceptualized as reflecting technical
progress. Following Rosenberg's (1976) view of rising materials prices as an
'inducement mechanism' or 'focusing device' for technological innovation,
the rising relative price of steel in the postwar US economy can be said to
have induced a cumulative innovative effort aimed at reducing the steel content of national output. The fact that innovation is required, rather than a
costless shift along a given production function, probably accounts for the
relative price inelasticity of total steel demand (elasticity of about 0.5).
111 Effects of imports on investment financing

The effects of import penetration on capital accumulation in the US steel

industry are estimated using in-sample simulations of the model described
in the previous section. The year 1962 is chosen as the starting point for the
simulations because it is the year of the optimal structural break in the price
equation (1.4), when prices became sensitive to import penetration and
capacity utilization. This was also the first year in which imports rose
above 5% of domestic consumption (except for the strike year 1959). The
simulations end in 1981 for the same reasons indicated in the previous
section.
A baseline simulation of the model was run assuming actual historical
values for all the exogenous variables, allowing all the endogenous variables
to adjust dynamically (see the Appendix for diagnostic tests of the model).
Then, the model was simulated under the counterfactual assumption that
import penetration remained at approximately 1962 levels through 1981.
Two counterfactual scenarios were tested: (1) the share of imports in
domestic consumption is constrained to 5%; and (2) the volume of imports
is constrained to four million net tons. In both cases, equation (1.10) for
import demand is dropped from the model, either IMPSHARE or
IMPORTS is set exogenously, and identity (1.9) is used to calculate the other
import variable.
Tables 2 and 3 give the means and growth rates, respectively, for the
baseline and counterfactual simulations. The endogenous variables are
listed in the same order as they appear in Table 1, except that the constant
dollar margin in (1.3) is replaced by the true PCM, defined as (PRICEUNITCOST)/PRICE (expressed as a percentage). The two counterfactual
l4

With the dependent variable measured in logs, steel demand decays at the rate of
2(.00025)! = O.S!% per year. This term is included in spite of the low !-statistic because
it improves the fit of the baseline forecast. A linear time trend is not used because it would
be collinear with log YMFR.

182 Import competition, investment finance, a n d cumulative decline

Table 2

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Variable

Sample means, 1962- 1981

Actual
Data

Baseline
Simulat~on

Counterfactual Simulations
(11

(21

Nores:

In billions of 1972 dollars, deflated by PINVEST.

Price-cost margin defined as I(PR1CE - UNICOST)/PRICEI x 100%.
In current dollars per net ton of products shipments.
In current dollars per net ton of trend product sh~pments
OUTPUT and CAPACITY are ~ndexesbased on 1977 output = 100. CAPUTIL is OUTPUT
as a percentage of CAPACITY
Measured In per cent
g Assumed lexogenously fixed).
In millions of net tons.
a

'

simulations generate very similar results, with scenario (2) - the more
restrictive assumption - generating slightly greater effects, as one would
expect.
The average PCM for the period 1962-1981 would have been about 10
or 11% higher with imports constrained (in scenarios (1) and (2), respectively), compared with the baseline forecast. Underlying this difference is
a faster average annual rate of price increase: 7.8% compared with 7.3%
in the baseline (recall that unit costs are exogenously fixed). The higher
prices are mainly due to the direct effects of the assumed restrictions on
import competition. There is also an indirect dynamic effect operating via
the feedback o f higher lagged profits (INTFUND,-,) on to current dividends (DIVPNT,). In addition, there is a small boost to prices from the
higher rate of capacity utilization.
Turning to the underlying determinants of capacity utilization, output
averages about 6% higher in the counterfactual scenarios (compared with
the baseline), while capacity averages only about 3% higher (see Table 2).
The increase in output is due to the fact that the restrictions on imports
more than offset the reductions in total steel demand (DOMCONS), which
are due in turn to the higher prices of steel products relative to substitute
materials. The counterfactual means and growth rates for DOMCONS are
lower than in the baseline simulation, confirming that the gains for domestic
production come partly at the expense of domestic steel consumption -

Robert A. Blecker

183

Table 3 Average annual growth rates. 1962-1 981 (in per cent)

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Variable
1)
21
31
41
5)
6)
7)
8)
9)
10)

fl

Actual
Data

Baseline
Simulation

Counterfactual Simulations
(1)

12)

INVEST
INTFUND
PCM
PRICE
DIVPNT
CAPUTIL
OUTPUT
CAPACITY
IMPSHARE
IMPORTS
DOMCONS

Nores: Growth rates are calculated from OLS regressions of the natural logs on linear time
trends except as noted.
Variables are defined as in Table 2.
a Estimated by AR1 procedure
Not significant at the 5% level (two-tailed test).
Assumed fixed.

especially when productivity growth is taken as exogenously fixed.

Internal funds are consistently well above the baseline levels in the
counterfactual scenarios. INTFUND averages $571.3 million higher in
scenario (1) and $653.8 million higher in scenario (2), compared with the
baseline, or about 27% and 319'0, respectively. The increased internal funds
are due primarily to the increase in the profit margin and only secondarily
to higher output. The higher constant-dollar MARGIN accounts for an
average 20% rise in annual internal funds in scenario (1) and a 23% rise in
scenario (2); higher OUTPUTaccounts for about a 3% rise in both scenarios
(evaluated at the sample means in logarithms).
The model also forecasts higher levels of investment spending as a result
of the increased internal funds and capacity utilization in the counterfactual
scenarios. Average annual real investment would have been $407.0 million
higher in scenario (1) compared with the baseline, and $459.8 million higher
in (2), or about 22% and 25%, respectively. The present value of the total
additional investment for the 20 years 1962-1981 is $7.5 billion in scenario
(1) and $8.5 billion in scenario (2), measured in 1972 dollars, assuming a
5% discount rate.
In order to appreciate the economic significance of these increased expenditures on new plant and equipment due to import restrictions, it is helpful to have some sense of the industry's capital requirements. One useful benchmark is the cost of constructing new, integrated steel plants in the
early 1970s, around the midpoint of our sample period. Crandall(1981: 78)
estimates that the capital costs for a new integrated steel mill were $41 1 per
net raw ton of capacity in 1972. Thus the total extra investment spending

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184 Import competition, investment finance, and cumulative decline

which would have resulted from restricting steel imports to 5% of the market
(or four million net tons) over a 20-year period could have purchased
approximately 18 (or 21) million tons of new integrated capacity, representing only about 12% (or 13%) of the total industry capacity of 156 million
tons in 1972, as estimated by Crandall (1981: 24-25).
Crandall (1981: 11) reports that 'the minimum efficient scale of a new
integrated "greenfield" plant is somewhere between 6 and 7 million raw
tons'. At $411 per ton, the total cost of one efficient, new integrated mill
would therefore have been between $2.5 and $2.9 billion in 1972. If all the
extra investment forecast in the counterfactual simulations had been devoted
to constructing new integrated mills, about three such mills could have been
built. While this would have quadrupled the number of new greenfield plants
actually built in the US after 1960 (the only one was Bethlehem Steel's Burns
Harbor, Indiana plant), it would clearly not have permitted a thorough
modernization of most US steelmaking facilities.
From a competitive viewpoint as well, building more integrated mills
might not have been a wise strategy, even if more capital funds had been
available. Barnett and Schorsch (1983) and Barnett and Crandall(1986) have
demonstrated that, by the late 1970s and 1980s. US integrated mills were
not cost competitive with their foreign counterparts, while the nonintegrated
minimills were still competitive. Barnett and Crandall (1986: 52-53; 65-67)
estimate that minimills could be built at a cost of about $300 per net ton
of capacity for bars and wire rod, or $700 for cold-rolled sheet coils, in 1985
prices. Using the implicit price deflator for steel investment, these figures
translate into approximately $140 and $325, respectively, in 1972 prices.
Therefore, over the entire 20 year period 1962-81, the industry could have
afforded about 53 million tons of additional minimill bar/rod capacity or
23 million tons of minimill sheet capacity under scenario (I), and 60 million
tons of barhod or 26 million tons of sheet with minimills under scenario
(2). Clearly, the industry could have afforded much more modernization if
it had ploughed the extra internal funds into more minimill construction,
rather than more integrated mills.

1V Effects of allowing for increased productivity growth

In order to demonstrate conclusively that the profits-investment link can
lead to a cumulative improvement or worsening of competitiveness, it would
be necessary to prove that additional investment in an industry would
reduce its unit costs in the long run. This would require showing not only
that more investment would increase productivity growth, but also that
increased productivity growth would not be offset by higher input prices
(especially wages). Since there is a close correlation between capital-labour
ratios and labour productivity in the steel industry, after correcting for
cyclical effects (Barnett and Schorsch, 1983: 147), we may infer that the

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Robert A . Blecker

185

increased investment which would have resulted from restrictions on imports

would have enabled productivity to rise more rapidly." The likely reaction
of wages to such restrictions is much less clear, however.
It could be argued that unions would have taken advantage of import
restrictions to win greater wage increases for their members. But whether
steel workers could have obtained wage increases greater than those actually
obtained in 1961-81 is doubtful. Steel wages rose faster than average for
US manufacturing in 1957-77 anyway, in spite of rising imports (Anderson
and Kreinin, 1981). Lawrence and Lawrence (1985) found striking evidence
that, in the 1970s, employed steelworkers obtained above-average wage
increases in a declining industry facing stiff international competition by
playing an 'end game' over the quasi-rents from the operation of existing
facilities. The authors found no evidence that steel wages rose more rapidly
during the two periods of binding protection in the 1970s; the 1971-72 voluntary restraint agreements; and the 1978-79 trigger prices. It is therefore far
from clear that wages would have risen more if the industry had suffered
less foreign competition and had better growth prospects. Indeed, unions
might have exercised more wage restraint if they had thought that the prospects for increased investment and job opportunities were brighter. In this
case, unions might have believed that higher cash flows would actually be
reinvested in the industry.
Given the uncertain effects of protection on wages, it seems safest to
assume that protection would have had a net negative effect on unit labour
costs through increased labour product~vity. In order to obtain a rough
estimate of how the results of the present simulations are affected if the
higher investment rates would have generated more rapid productivity
growth, the counterfactual simulations described in the previous section
were rerun with labour productivity assumed to grow at a compounded 1%
per year more than it actually grew, starting in 1962. The 1% increase in
the productivity growth rate was arrived at in two ways. First, the additional
investment forecast by the model in scenario (I), with imports constrained
to 5% of the market, is estimated to make net capital per worker grow about
0.8% per year faster than in the model baseline.I6 Assuming a unitary
elasticity of labour productivity with respect to net capital per worker, the
1'

16

The author attempted to estimate a Kaldorian technical progress function by regressing the
annual growth rate of labour productivity on the rate of increase in (estimated) capital per
production worker, after controlling for changes in capacity utilization and other variables.
While significant positive coefficients were obtained, the quantitative results were very sensitive to the precise specification chosen, and those estimated coefficients are not relied upon
here. The estimation of the capital stock is described in the following note.
The net capital stock was estimated by accumulating annual real investment spending,
assuming a 20-year service life for all steel investment and using straight-line depreciation.
Hours of production workers in the counterfactual scenario were estimated by multiplying
actual hours for each year times the ratio of counterfactual OUTPUT to OUTPUT from
the baseline simulation.

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186 Import competition, investment finance, and cumulative decline

former would also rise about 0.8% faster per year. Secondly, the BLS
index of output per production worker hour in steel rose by about 0.6% per
year slower than the average for all US m a n ~ f a c t u r i n g . A
' ~ fairly neutral
assumption is that protection from imports could at least have enabled the
industry to achieve the average productivity growth rate for all manufacturing (Scott, 1989). I rounded these growth differentials up to 1% to
compensate for the possible effects of additional investment in lowering
energy and materials costs, which could not be modelled so easily due to
the heterogeneity of these inputs.
The results of the simulations with variable productivity are summarized
in Table 4 for scenario (l).'"he
main difference is that the price increases
are much more moderate, as lower unit costs are only partly offset by profit
margins which are only slightly higher. As a result, total domestic consumption and output are both higher, and the costs of the hypothesized protection to domestic steel consumers are greatly reduced. As Figures 1 and
2 show, in the first few years after imports are controlled, domestic prices
and consumption in the counterfactual simulation with increased productivity are close to their trajectories in the counterfactual simulation with constant productivity. However, after 10-20 years have elapsed, the simulation
with increased productivity generates forecasts closer to the model baseline
than to the counterfactual simulation with constant productivity. By 1981,
the final year in the simulations, the price is forecast to be $566 per net ton
with increased productivity, about 4.6% higher than in the baseline forecast
($541),but about 6.4% lower than in the counterfactual forecast with constant productivity ($605).Similarly, 1981 domestic consumption falls to only
100.5 million net tons in the simulation with increased productivity from
102.8 million in the baseline, as compared with 97.2 million in the counterfactual simulation with constant productivity.
V Conclusions and implications

If the US steel industry had been fully insulated from rising imports after
1962, it would have benefited from the ability to raise more internal funds
by setting higher profit margins as well as by selling more output. With the
PCM about 10-1 1% higher and output about 6% higher, real internal funds
would have been about 27-31 To higher and real investment expenditures
would have been about 22-25% greater. These expenditures could have
enabled the industry to replace or refurbish a portion of its plant and
-

l7

'8

--

Growth rates are estimated by least squares. The index of production worker productivity
for all manufacturing was obtained by dividing the index of manufacturing output by the
index of average weekly hours of production workers (Handbook of labor srarisrtcs, 1989;
both indexes based on 1977 = 100).
Results for scenario (2) were qualitatively similar and are omitted for reasons of space.

Robert A . Blecker

187

Table 4 Means and growth rates for alternative simulations: constant versus increased productivity (Scenario 1 -Imports Restricted to 5% of Market)
Means

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Variable

Constant

Growth Ratesa
Increased

Constant

Increased

1) INVEST
2) INTFUND
3) PCM
4) PRICE
51 DIVPNT
6) CAPUTIL
7) OUTPUT
8) CAPACITY
9 ) IMPSHARE
10) IMPORTS
1 1) DOMCONS

Notes: Variable are defined as in Table 2.

Growth rates calculated as in Table 3.
Simulation with increased productivity growth assumes labour productivity rose by 1% per
year more than it actually did.
a In per cent per year.
Not significant at the 5% level.
Assumed (exogenously fixed).

equipment. Although the additional expenditures would not have been

enough to modernize most of the industry - especially if the funds had been
spent on greenfield integrated mills - the simulations do show that a 'profit
squeeze' due to import competition significantly restricted the ability of
firms to finance their capital expenditures. To this extent, it may be said that
import penetration contributed to a 'vicious circle' of cumulative decline.
The analysis in this paper supports the view that competitive advantages
or disadvantages, to a certain extent, can be created or lost by specific
historical events and social institutions. It is also implied that 'artificial' gains
or losses of competitiveness (e.g., due to temporary undervaluation or overvaluation of a nation's currency) can have permanent, potentially irreversible effects. From this perspective, comparative cost advantages and
disadvantages at any given point in time are not merely manifestations of
inherent comparative advantages based solely on exogenous factor endowments. The analysis also implies that the putative benefits to domestic steel
consumers of allowing steel imports are exaggerated by analyses which fail
to take account of the productivity losses engendered when investment
finance is constrained by import competition.
It does not necessarily follow from this analysis that more protectionism
was actually warranted for the US steel industry during the 1960s and 1970s,
or that additional investment could have permanently averted its decline.
For one thing, mere protection would have left steel firms free to plough
the additional funds into greater diversification out of steel, in the absence
of a more comprehensive industrial policy. Unless steps were taken to ensure

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188 Import competition, investment finance, and cumulative decline

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Million Net Tons

120

Baseline
70

I
1962

Figure 2

1964

I
1966

1968

Productivity Productivity
I

1970

1972

I
1974

1976

I
1978

I
1980.

US domestic steel consumption, alternative simulations, 1962-81

Source: Author's calculations. Simulations with constant and increased productivity both assume imports constrained to
5% of consumption.

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190 Import competition, investment finance, and cumulative decline

that additional profits were actually invested in raising steel productivity,
the negative allocational effects on steel consumers emphasized in the traditional analyses (e.g., Crandall, 1981; 1987) might have predominated. The
need to compel firms receiving protection (or subsidies) to reinvest in modernizing their steel operations is especially important in the light of the differences found in our forecasts for steel prices and consumption in the
counterfactual simulations with constant versus increased productivity.
Another difficulty with protecting the steel industry arises from the fact
that steel is a mature product with a slowly growing market, especially in
advanced industrialized countries such as the United States. For this reason, efforts to sustain large, integrated steel works in all the industrialized
countries have only led to global excess capacity (Barnett and Schorsch,
1983: 38-47). Our estimated total steel demand function (I . l l ) shows that
steel demand is income-inelastic and has an accelerating negative time trend.
And even the insignificance of accelerator terms in the investment function
( I ) can be interpreted as reflecting the poor prospects for the growth of steel
demand. Protection simply could not have preserved the relative importance
which steel had in the US economy in the postwar years, and excessive
protection could have hindered necessary structural changes at high social
costs.
There may be situations, however, in which a more activist response to
a loss of competitiveness in steel might be indicated. For example, macroeconomic imbalances and exchange rate fluctuations can potentially cause
lasting damage to domestic producers. For the period 1979- 1983, about 55%
of the employment losses in the US steel industry have been attributed to
the overvaluation of the dollar combined with 'sluggish real income growth'
(Grossman, 1986). In this situation, if profits and investment were also curtailed, a case for some kind of remedial intervention could be made.
The connection between pricing, profitability, and investment which has
been identified in this paper also suggests a reorientation of economic theory
along the lines suggested (in a different context) by Heim and Mirowski
(1987). In particular, this connection implies a shift in the focus of price
theory, away from the traditional view of prices as 'scarcity indexes,' toward
a conception of prices as instruments in firms' competitive efforts to expand
- a shift advocated earlier by Robinson (1962) and Levine (1982). In this
light, the long-standing debate about whether industrial prices are 'flexible'
or 'rigid' has missed the point. This debate has been based on the presumption that any sign of price flexibility in response to demand conditions
indicates a tendency toward neoclassical market-clearing pricing; thus critics
of neoclassical price theory have been forced to claim that prices are 'rigid'.
An alternative approach is to view flexible prices as signalling firms' changing abilities to finance their growth along irreversible paths, rather than as
signals inducing them to allocate resources efficiently in a preordained
equilibrium state.

Robert A . Blecker

191

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This alternative approach would place the expanding business firm, rather
than the intertemporal-utility-maximizing household, at the centre of the
analysis of capital accumulation. On the one side, gross realized profits are
the main source of saving; on the other side, expected net profits are the
principal inducement to invest. Investment decisions, made at the microlevel
by competing firms, determine income levels and growth rates at the macrolevel. The analysis in this paper is intended to validate the 'microfoundations' of this approach at the industry level.
VI References
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American Iron and Steel Institute. Annual Statistical Report. Various
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Anderson, R.G. and Kreinen, M.E. 1981: Labour costs in the American steel
and auto industries. World Economy 4, 199-208.
Barnett, D.F. and Crandall, R.W. 1986: Up from the ashes: the rise of the
steel minimill in the United States. Washington: Brookings.
Barnett, D.F. and Schorsch, L. 1983: Steel: upheaval in a basic industry.
Cambridge, Mass: Ballinger.
Blecker, R.A. 1989: Markup pricing, import competition, and the decline
of the American steel industry. Journal of Post Keynesian Economics
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Broude, H.W. 1963: Steel decisions and the national economy. New Haven:
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Crandall, R.W. 1981: The USsteel industry in recurrent crisis. Washington:
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- 1987: The effects of US trade protection for autos and steel. Brookings
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Dornbusch, R. 1987: Exchange rates and prices. American Economic
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Fair, R.C. 1970: The estimation of simultaneous equation models with
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Fazzari, S.M. Hubbard, R.G. and Petersen, B.C. 1988: Financing constraints and corporate investment. Brookings Papers on Economic
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Fazzari, S.M. and Mott, T.L. 1986-87: The investment theories of Kalecki
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Feinberg, R.M. 1986: The interaction of foreign exchange and market power

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192 Import competition, investment finance, and cumulative decline

effects on German domestic prices. Journal of Industrial Economics
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Grossman, G.M. 1986: Imports as a cause of injury: the case of the US steel
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Matanaka, M. 1976: Several efficient two-step estimators for the dynamic
simultaneous equations model with autoregressive disturbances. Journal of Econometrics 4, 189-204.
Heim, C.E. and Mirowski, P . 1987: Interest rates and crowding-out during
Britain's industrial revolution. Journal of Economic History 47, 11739.
Wooper, P. and Mann, C.L. 1989: Exchange rate pass-through in the 1980s:
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Jondrow, J.M. 1978: Effects of trade restrictions on imports of steel. In
Dewald, W.G., editor, The impact of international trade and investment on employment, Washington: US Department of Labor.
Kaldor, N. 1970: The case for regional policies. Scottish Journal of Political
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Kalecki, M. 1971: Selected essays in the dynamics of the capitalist economy.
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Lawrence, C. and Lawrence, R.Z. 1985: Manufacturing wage dispersion:
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Lawrence, R.Z. 1983: Is trade deindustrializing America? A medium-term
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Levine, D.P. 1982: Determinants of capitalist expansion. Economic Development and Cultural Change 30, 299-320.
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Means, G.C. 1962: Pricing power and the public interest: a study based on
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193

Rosenberg, N. 1976: Perspectives on technology. Cambridge: Cambridge

University Press.
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VII Appendix

This Appendix discusses the diagnostics of baseline simulation of the model

presented in the text. The first two columns of Table 2 compare the means
of the baseline forecasts of the endogenous variables with the actual sample
means; growth rates are compared in Table 3. Table A-1 gives the root mean
squared errors (RMSEs) for the baseline forecasts, both in levels and in
natural logarithms (the latter measured in percent), along with Theil's u
(coefficient of inequality)."
For purposes of the present study, only the forecasts of the long-run
trends of the variables are of interest, and the model does quite a good job
of simulating those trends. In fact, the simulations track the annual changes
very well for several variables (PCM, PRICE, CAPUTIL, OUTPUT, and
DOMCONS), and moderately well for others (IMPORTS, IMPSHARE,
INTFUND, and INVEST). The baseline forecasts of the other two variables
(DIVPNTand CAPACITY) essentially look like trends or moving averages
drawn through the actual series. Generally speaking, the more the variables
depend on lagged endogenous variables, the worse the model forecasts their
year-to-year fluctuations. Nevertheless, the simulations forecast the sample
means and growth rates quite closely for all the variables.
The baseline forecasts of investment spending (INVEST) and internal
funds (INTFUND) both underpredict the amplitude of the cyclical swings,
and miss some of the turning points, while approximating the long-run

19

Theil's (1966) u-statistic, which is 0 for perfect forecasts and 1 for the 'naive' forecast of
no change, was designed to evaluate how well models forecast short-term percentage
increases. The magnitudes of these statistics in Table A-1 should not be surprising for a
20-year historical simulation.

194 Import competition, investment finance, and cumulative decline

Table A-1

Error diagnostics of baseline forecast ( ~ sample.

n
1962-81)

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Variable

RMSE in
Levels

RMSE in
Logarithms

Theil's
u

11 INVEST
2 ) INTFUND
3 ) PCM
4 1 PRICE
5) DIVPNT
6 ) CAPUTIL
7) OUTPUT
8 ) CAPACITY
9) IMPSHARE
10) IMPORTS
1 1 ) DOMCONS
Nores: The root mean squared error (RMSEI in levels is measured In the same units as the
variable (see Table 2 for mean levelsl.
The RMSE in logarithms is expressed as a percentage.
Theil's u IS the 'coefficient of inequality' as def~nedIn Theil ( 1 966). the ratlo of the percentage RMSE for the baseline forecast to the percentage RMSE for the 'na~ve'forecast of no
change

trends reasonably well. The forecast of the mean level of INVEST is about
0.5% above the actual mean, while the forecast of the mean of INTFUND
is only about 1.5% above the actual (see Table 2). The large RMSEs for INTFUND (see Table A-I) are due mainly to the failure of the model to predict
the wild fluctuations of this variable in just three years: 1974; 1977; and
1981.
The model slightly overpredicts the means for PRICE and the PCM,
but only by about 2% in each case. The RMSEs are proportionately small
for these variables. The baseline price series grows at about the actual
average annual rate of 7.3% (see Table 3). The model more seriously overpredicts the level of dividends paid per net ton (DIVPNT), with a greater
proportional RMSE and a Theil's u just over 1. However, since the elasticity
of PRICE with respect to DIVPNT is only 0.16 (equation 1.4), the overprediction of DIVPNT has only a slight effect on the forecasts of PRICE
and PCM.
The model comes within 0.4 percentage points of predicting the mean
capacity utilization rate, with a proportionally small RMSE. The close fit
for CAPUTIL results from the fact that while the model systematically
underpredicts both OUTPUT and CAPACITY, it still predicts the
OUTPUT/CAPACITY ratio quite well. Moreover, most of the year-to-year
fluctuations in CAPUTIL are due to fluctuations in OUTPUT, which the
model simulates very closely. While the annual forecast changes in CAPACITY are worse than naive extrapolation, according to the high Theil's u,
the forecast of CAPACITY has the lowest logarithmic (percentage) RMSE

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Robert A. Blecker 195

of any equation." The forecast and actual series grow at the same average
annual rate (0.8%) for the entire period, and the forecast mean is less than
2% below the actual.
With regard to imports, the baseline forecasts of the means and growth
rates of IMPORTS and IMPSHARE are very close to the corresponding
statistics for the actual series. The RMSEs are proportionally large in the
forecasts for these variables because the forecasts miss some of the turning
points by one or two years, probably due to the lagged dependent variable
in (1.10). The model predicts total domestic consumption (DOMCONS)
much more closely. The mean for the baseline forecast is only 1% lower than
for the actual series, and the RMSEs are not large. Domestic consumption
grows slightly more slowly in the baseline forecast compared with the actual
trend (1.2% per year versus 1.4%), while imports grow at the same rate
(6.1'70).

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20

The reason for this discrepancy is that the predicted series (P)lags consistently behind the
actual series ( A ) while the latter rises rapidly from 1965 to 1977; hence the 'predicted change'
(PI - A , - , ) / A , - , is negative while the actual change is positive for much of that period.
While this inflates Theil's u, it does not necessarily imply large RMSEs, since the proportional difference between P, and A , is never very large.